Why did net income fall in 2004 even though revenues grew 7.8%?

Salaries and benefits rose to 40.1% of revenues from 39.8%, and supply costs rose to 16.6% from 16.2%, with cardiac, orthopedic and drug-eluting stent costs driving the increase. The provision for doubtful accounts also climbed to 11.4% of revenues from 10.1%. Lower 2003 one-time gains and a 2003 favorable government settlement were not repeated in 2004. Net income was also helped by one-time reserve and estimate changes that partly masked these pressures.

How much did HCA spend returning capital to shareholders in 2004, and how was it financed?

HCA repurchased 77.4 million shares for $3.109 billion in 2004. This included the $2.501 billion modified Dutch auction tender offer completed in November 2004 at $39.75 per share, plus open-market purchases. The company financed it largely with a new $2.5 billion credit agreement, $1.25 billion drawn under the revolver and term loan, and $1.25 billion of new senior notes (5.5% due 2009 and 6.375% due 2015). Quarterly dividends were increased from $0.02 to $0.13 during 2004 and to $0.15 for 2005.

What are the main regulatory and legal risks to HCA?

HCA operates under a Corporate Integrity Agreement with the OIG running through 2009, and breach could bring substantial penalties or exclusion from Medicare and Medicaid. The IRS is contesting about $404 million in taxes and interest for prior years, and HCA deposited $109 million in December 2004. Proposed changes to the Medicare rehabilitation 75% rule and a possible restrictive rehabilitation LCD could reduce rehab payments. Physician self-referral (Stark) and anti-kickback rules also create compliance exposure, and the moratorium on physician-owned specialty hospitals is set to expire in June 2005.

How will the new uninsured discount policy affect HCA's financials?

Effective January 1, 2005, HCA began offering discounts to uninsured patients who do not qualify for Medicaid or charity care, similar to discounts given to managed care plans. Management expects this to lower reported revenues and the provision for doubtful accounts by generally corresponding amounts. Uninsured admissions rose 9.7% in 2004, and 2004 charity care and uninsured discounts totaled $926 million, so the policy change could meaningfully reshape reported revenue and bad-debt trends in 2005.

Is HCA's balance sheet still strong enough to support its capital spending and debt?

Leverage increased substantially. Long-term debt including current maturities was $10.530 billion against stockholders' equity of $4.407 billion, and the debt-to-capital ratio is materially higher than in 2003. About $2.8 billion of debt is variable-rate, so a 1% rate increase would reduce pretax earnings by roughly $28 million. HCA has $1.75 billion of revolver capacity (about $1.378 billion available as of February 28, 2005) and a $1.5 billion shelf registration. Management expects operating cash flow, credit facility availability and debt market access to cover needs for the next twelve months, and it plans capital expenditures of about $1.6 billion in each of 2005 and 2006.

HCA 10-K FY2004 Annual Report — Revenue, Net Income, EPS

01—Abstract

Summary

Summary of the 10-K filed March 11, 2005. Cited figures are marked; the original filing is the authoritative source.

HCA Inc. closed 2004 with revenues of $23.502 billion^a, up 7.8% from $21.808 billion in 2003, driven by a 5.5% increase in revenue per equivalent admission and a 2.2% rise in equivalent admissions.

Net income fell 6.5% to $1.246 billion^b, and diluted EPS declined 1.1% to $2.58 from $2.61. Results were flattered by favorable one-time items: a $59 million reduction in professional liability reserves and a $46 million favorable change in the doubtful accounts estimate, partly offset by hurricane costs of about $40 million and a $12 million impairment. Underlying margins came under pressure as the provision for doubtful accounts rose to 11.4% of revenues from 10.1%, reflecting growth in uninsured patients and weaker collectability.

Cash from operations was strong at $3.049 billion^c. The balance sheet changed materially in 2004. HCA spent $3.109 billion repurchasing 77.4 million shares, including a $2.466 billion Dutch auction tender offer, which cut stockholders' equity to $4.407 billion from $6.209 billion.

Long-term debt rose to $10.530 billion^d from $8.707 billion. Following the tender offer, S&P and Fitch cut HCA's senior debt to BB+, and Moody's cut it to Ba2, so the company moved below investment grade. Dividends were raised to $0.13 per quarter in 2004 and to $0.15 for 2005.

Key risks for investors include heavy reliance on government programs (Medicare and Medicaid together accounted for about 53% of admissions), a concentration of 76 hospitals in Florida and Texas, pending IRS disputes covering about $404 million, the Corporate Integrity Agreement with the OIG, and a restrictive Medicare rehabilitation 75% rule. Pressure on uninsured collections and payer mix is likely to continue, and the new 2005 uninsured discount policy is expected to lower both revenues and the provision for doubtful accounts.

02—Key points

Key Highlights

Revenue grew 7.8% to $23.5 billion, driven mainly by a 5.5% increase in revenue per equivalent admission rather than volume growth.
Net income declined 6.5% to $1.246 billion ($2.58 diluted EPS), despite $59 million of favorable professional liability reserve adjustments and a $46 million favorable doubtful accounts change.
The provision for doubtful accounts rose to 11.4% of revenues from 10.1% in 2003, reflecting growth in uninsured accounts and weaker collectability; uninsured revenue exposure is a key margin risk.
Shareholders' equity fell to $4.407 billion from $6.209 billion after $3.109 billion of share repurchases, including a $2.501 billion Dutch auction tender offer for roughly 13% of shares.
Long-term debt increased to $10.530 billion from $8.707 billion; S&P and Fitch downgraded HCA to BB+ and Moody's to Ba2, leaving it below investment grade.
Operating cash flow was $3.049 billion, up 41% from $2.166 billion, although 2003 was depressed by $942 million of government settlement payments.
Concentration risk is high: 76 of 189 hospitals are in Florida and Texas, and Medicare and Medicaid made up about 53% of admissions. Dividends rose to $0.15 per quarter for 2005.

03—Questions

Frequently Asked Questions

Why did net income fall in 2004 even though revenues grew 7.8%?
Salaries and benefits rose to 40.1% of revenues from 39.8%, and supply costs rose to 16.6% from 16.2%, with cardiac, orthopedic and drug-eluting stent costs driving the increase. The provision for doubtful accounts also climbed to 11.4% of revenues from 10.1%. Lower 2003 one-time gains and a 2003 favorable government settlement were not repeated in 2004. Net income was also helped by one-time reserve and estimate changes that partly masked these pressures.
How much did HCA spend returning capital to shareholders in 2004, and how was it financed?
HCA repurchased 77.4 million shares for $3.109 billion in 2004. This included the $2.501 billion modified Dutch auction tender offer completed in November 2004 at $39.75 per share, plus open-market purchases. The company financed it largely with a new $2.5 billion credit agreement, $1.25 billion drawn under the revolver and term loan, and $1.25 billion of new senior notes (5.5% due 2009 and 6.375% due 2015). Quarterly dividends were increased from $0.02 to $0.13 during 2004 and to $0.15 for 2005.
What are the main regulatory and legal risks to HCA?
HCA operates under a Corporate Integrity Agreement with the OIG running through 2009, and breach could bring substantial penalties or exclusion from Medicare and Medicaid. The IRS is contesting about $404 million in taxes and interest for prior years, and HCA deposited $109 million in December 2004. Proposed changes to the Medicare rehabilitation 75% rule and a possible restrictive rehabilitation LCD could reduce rehab payments. Physician self-referral (Stark) and anti-kickback rules also create compliance exposure, and the moratorium on physician-owned specialty hospitals is set to expire in June 2005.
How will the new uninsured discount policy affect HCA's financials?
Effective January 1, 2005, HCA began offering discounts to uninsured patients who do not qualify for Medicaid or charity care, similar to discounts given to managed care plans. Management expects this to lower reported revenues and the provision for doubtful accounts by generally corresponding amounts. Uninsured admissions rose 9.7% in 2004, and 2004 charity care and uninsured discounts totaled $926 million, so the policy change could meaningfully reshape reported revenue and bad-debt trends in 2005.
Is HCA's balance sheet still strong enough to support its capital spending and debt?
Leverage increased substantially. Long-term debt including current maturities was $10.530 billion against stockholders' equity of $4.407 billion, and the debt-to-capital ratio is materially higher than in 2003. About $2.8 billion of debt is variable-rate, so a 1% rate increase would reduce pretax earnings by roughly $28 million. HCA has $1.75 billion of revolver capacity (about $1.378 billion available as of February 28, 2005) and a $1.5 billion shelf registration. Management expects operating cash flow, credit facility availability and debt market access to cover needs for the next twelve months, and it plans capital expenditures of about $1.6 billion in each of 2005 and 2006.

04—Continue

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